Rolls-Royce Holdings plc

John Dawson – Investor Relation Warren East – Chief Executive Officer David Smith – Chief Financial Officer

Avi Hoddes – Millennium Partners Harry Breach – Raymond James

Thank you Hugh, and good afternoon ladies and gentlemen for those in U.K. and good morning to those of you in the United States.

This call is primarily for the benefits of our U.S. shareholders who hopefully have an opportunity to dial-in this afternoon and, of course, to analyst and investors here in the U.K.

who may have further questions that they wish to ask management. My name is John Dawson, I'm Head of the Investor Relations at Rolls-Royce.

With me are Warren East, Chief Executive and David Smith, our Chief Financial Officer. Warren will be taking the lead on the presentation today.

Before hand it over to him, I would remind you to review our Safe Harbor statement which is attached to the PowerPoint and is available on our website. We will have plenty of time for questions at the end.

The presentation which should last about five minutes. Please wait for the operator's instructions to register for question at the end of our opening remarks.

Thank you. And without further ado, let me hand you over to Warren

Thanks John, good morning everyone in the call in the U.S. Thanks for joining us today.

And I apologize about the short notice. We have an hour available for the call, but our IR team will be able to communicate after the call and we'll set of meetings and telephone conferences as required.

So, as you've seen in the U.K., this morning we issued an interim management statement and that covered three main areas. Firstly, initial findings from the operational review that I've been doing; secondly, an update on the outlook for 2015; and finally, also our current views on 2016 and the headwinds that we're facing transitioning from 2015 into 2016 from a profit point of view.

Now, this IMS included some very difficult, but necessary messages and that's why we want to take time to hold a conference call and be able to spend time with investors explaining more about issues and importantly what we plan to do about things. So, let's go on to the key messages, slide the first -- first slide.

I'd like to reiterate to start with that after four months of being in the business, everything I have seen has confirmed the good things with the vessel. My view that the company has a strong portfolio of products and services, definitely has world-class engineering capability, and actually is well-positioned in the market to generate high market shares and strong cash flow and actually, in the longer term higher returns on capital.

And we're preparing for an increase in our wide-body engine production and increase which doubles our production from around 300 to around 600 engines per year and that is a reflection of a very strong order book and a growing market share. So, that's the good stuff.

During the year, we've also taken steps to improve our balance sheet, strengthen our balance sheet and improve liquidity and so that puts in a strong position as well. But we've been faced with a number of headwinds that continue to impact 2015 and they have material implications for 2016 and I will discuss that in a bit more detail shortly.

But in summary, in common ways most industry players were seeing significant changes in some of the end markets in which we operate. This is primarily lower demand within the corporate jets and regional jet market, reduced utilization of older wide-body Jets as well.

And we're also seeing a continued and even more severe deterioration in the offshore sector to which our Marine business is exposed. For the current year, our overall guidance is actually unchanged although we do expect profit to be at the lower end of that range.

And our assessment of the profit headwinds for 2016 however totaled some £650 million in total and that equates to a further £350 million of headwinds compared with what we talked about in July. Good news in cash flow terms however we expect a much more consistent year-on-year performance and we can explain that difference in a little while.

But clearly the conditions that we face are challenging and our expected performance is disappointing and for me it's also striking that the revenue impact of these changes in the market, the revenue impact is relatively small but the profit impact for us is large. Interesting observation and we will come back to that.

So as you know I have been undertaking an operational review for the past few months and I had been preparing to present conclusions to you later in November. But in the light of the numbers coming together for today and reflecting on the size of that we decided that I should definitely bring forward the announcement of at least a headlines of what I think we need to do as a result of the operational review that's been going on.

And I understand the whole thing makes unpleasant news and is a good opportunity to make sure that people have time to digest this before we start talking on November 24. Let's look at some guidance, 2015 guidance.

We've guided to the lower end of the profit range that we gave in July, but otherwise it is actually unchanged on a constant exchange rate basis. It's a reflection of growing headwinds that we've seen coming through the year, but those growing headwinds are offset by some of the mitigating actions that we've already taken.

The impact in 2016 is more severe as we feel the full force of these market impacts and some of the market changes and in particular some of those changes, which have come along a bit faster than we had previously anticipated. Let's turn to 2016 now.

We set out in our statement and we're outlining on this slide how the key factors that we see that are making up the challenges for the coming year. The £650 million headline figure consist of £300 million that were identified in July in particular relating to the impact of the slowdown in the Trent 700 order book.

I know that we believe the initial estimation that we made in July remains absolutely valid, so this is essentially the same position that we were in July. However, since then, we can also see a further approximately £100 million impact if we look at corporate and regional jets together.

And in the corporate jet market, we're seeing further weakness in demand for various business jet engines particularly for new orders. And then in the regional market, we're seeing weakening demand for aftermarket services in the 50 to 70 seat category where people are simply not flying those airplanes for a variety of reasons.

If we look in the large engines area than, we have about day £100 million to £150 million headwind in large engines. We are seeing good growth in stores for us, but that is being offset by some selected short term weaknesses on some older widebody programs and this is where aircraft are being temporarily parked up by some players in the industry as they manage a transition to new more efficient aircraft.

The net effect of that is about £100 million to £150 million of profit. Finally there is an additional 75 million to 100 million of further headwinds for the Marine business, as the market there continues to weaken for both the original equipment sales and for services in the offshore sector.

So these profit effects taken altogether are quite dramatic; however, as I mentioned earlier the impact on cash flow is a lot less and that is because of the norm cash nature of the adjustments as a result of TotalCare accounting adjustments in 2015 compared with those adjustments in 2016. There's a bigger adjustment in 2015, a positive and a smaller adjustment in 2016 therefore the negative profit swing is somewhat less by the time you look at it from a cash point of view.

And if you add that reduced cash – add to that reduced cash impact, expected benefit of improved working capital you get the neutral position that we are talking about in the guidance today or in the estimations today. So, now, let's look at the slide on restructuring, because I would like to say a few words about this in this context.

This was going to be talked about initially on 24 November, we will come back on 24 November, and obviously add little more color to this and we'll probably add even more color in February as well because it is an ongoing problem. So let's say, when David first became CFO this time last year he said that one of the jobs was to improve our management information, forecasting and business systems.

That was already in motion when I became CEO in July, a major and complex problem and that's well underway. From what I have seen over the last several months and importantly illustrated by the news today, we've got a lot more work to do on that.

Right now it's not working properly and it needs to work better. My key requirement is to add a bit of pace to this and simplicity and accountability into decision-making in the business.

And the business itself has really shown itself over the last several months to be much less able to respond to changes in the market conditions than should be the case. I also think, I m referring to the point made earlier about small revenue changes resulting in large profit changes.

I think we are going far too much fixed cost and we're not sufficiently flexible in managing the cost base in response to changing market conditions. And actually that's just unacceptable for a world-class business and particularly where we are operating in a very competitive environment.

So we need to put into place some significant changes to make this business more resilient and sustainable and we need to move a bit more rapidly with the restructuring in the light of the fact that we are facing further weakening in some of our key markets. It's too early to provide detailed costings of proposed restructuring and we will get further information, as I said, later in this month on the 24th and we will provide, I'm sure, more detail with our results in February and updates after that.

In the meantime, the previously announced restructuring that is going in our Marine and Aerospace businesses, I'm pleased report, that is actually going well, and I'm also confident that the benefits that the actions that we are announcing today will also have a significant impact and we will be having a significant impact right the end of 2017. With that we will open up to questions.

Thank you.

Thank you. I have two questions.

Earlier today BAE said that they were going to be cutting your fighter production of about 50%, if you think about defense next year early this morning, you expressed optimism about transfer aftermarket. How would the headwinds from the euro check going down compare with the potential talent from the aftermarket, is it a disproportionately profitable early business?

And then on the Land & Sea, I was wondering if I could just ask on the order side, how are orders shaping up in Marine and Power Systems in the second half versus the first half could you give us some color or flavor or magnitude of change you're seeing their sequentially? Thank you.

I did see the BAE announcement, although I haven't had a chance to discuss that with our French team, but in terms of our own views on that we already had basically a fairly conservative view on the engine production. Clearly, there are two recent opportunities one around the Dubai contract which was announced a few weeks ago and then one that's still speculative at the moment around Saudi Arabia that could provide some -- one which will that could provide some upside, but we had a fairly low view in terms of our own forecast around production on that engine.

In terms of Land & Sea orders, very different picture here and partly reflects the fact that the Power Systems is actually exposed to quite a range of the -- top of all segment, wide range of markets. Yes, they do have some exposure to global commodities in mining and in oil but we already are experiencing very low level of demand in those markets anyway.

So Power Systems went out in June with a record order book. They actually had a decent order intake since then so their order book is in reasonable shape.

Clearly it's a shorter cycle business so we don't tend to be fully covered for the next year on orders anyway. But in terms of the question that's pretty satisfactory.

Offshore Marine is a very different picture there. We've seen actually since the midyear quite a significant drop in further order intake which is the reason that we are taking based on that now having to continue for three or four months taking a view that, that's likely to result in a fairly significant downgrade in revenue next year.

So quite different pictures I think between the two businesses.

Okay, thank you.

Good morning, good afternoon Warren and David. Can you hear me?

Yes.

Yes.

Yeah, perfect. Three questions, firstly can you give us any flavor on the 330 program, one of the concerns back in July was about potentially increasing sort of competitive pressure for the remaining undecided customers for the remaining 330 CEO production slots if I can call it that.

How are things progressing in terms of your campaign wins on that, is it sort of inline with, or better than or worse than what you were hoping, and can you give us a flavor similar on the pricing for that? Second question was just looking at the time and material side of the business aside from the specific operators of certain older widebody's that you touched on in the press release, can you give us any feel for your time and material aftermarket demand in particular outside of those specific operators?

And then final question is, David earlier on you touched on no change to your expectation or maybe that the Civil guys expectation of 25 year service life on average for large engines, but I'm wondering if within that 25 years, are they making any change about the average annual flying hours within that? I guess, specifically what I'm getting at is are we passing an environment where there is a greater propensity prematurely to pass these older widebody's, because there's so much new supply coming on stream, and therefore, are they just – is it going to be across the board issue for widebody's, or do you feel that we can concentrate on what's happened today on certain operators that had issues quite specific to them?

Yes. Okay.

Let me take those and Warren can, obviously, add anything as I go through. But in terms of the 330, actually the estimate that we made at the end of June, early July of the impact here has actually proven remarkably resilient, so I said at the time we thought the volume would be between 80 and 100 over the next couple of years and that's proved to be a good assumption, and the pricing assumptions we made also.

So actually that number is pretty well, was pretty accurate. We absolutely did see intense pricing pressure that we have now the majority of those deals are now firm there maybe one or two that still need a bit more work, but certainly with the Chinese orders it will agree part of the President's visit a couple weeks back then that is looking in pretty good shape in terms of the 330.

So not good news in terms of margins, but in line with what we thought. In terms of T&M specifically, I mean, there's sort of a couple of aspects of that firstly clearly one of the things that we're doing is continuing to increase reliability which does unfortunate push out show visits and certainly in terms of the discretion of people to do that, than that gives him bit more flexibility.

But the basic issue is much more around flying hours and the – and those older aircraft being parked then particularly T&M driven at the moment. And now on the 25 years, maybe I will just repeat what I said again, so I didn't say, what I said was this morning was, the actual evidence is actually pretty consistent over the last 20 years in terms of being about 25 years on average that really – that number really hasn't moved.

It is remarkably the same over the last 20 years. However when we think about programs ourselves we clearly look at different scenarios and that's not necessarily the assumption that we use when we're looking at individual programs, individual airline deals we will take scenarios around that one coming up with our own pricing assumptions and evaluating the programs, all I was really saying is actually the incident hasn't changed that we are more cautious in that when we do our own evaluations.

Can I possibly just press just a little bit more on the T&M side, if we were to isolate the specific carriers that you mentioned in the press release, is your T&M revenues in the second half so far up year-on-year or about the same or something else?

I think in a way the issue is all about utilization, it is not about T&M contracts at all. It's about the fact that planes are simply not being used and that is what is causing the issue that we are flagging as an issue that's going to be a headwind in 2016.

Okay. Well, I'll leave it that.

Thank you. Thank you, David.

Okay.

Yes, good afternoon. Tristan Samson [ph] from Exane.

I wanted to come back to the pressure that you are seeing on the older widebody's aftermarket and you mentioned that the key issue was certainly with number of our aircraft being parked. Now, if we look at how these operate over the years the impression that the main recent evolution was an acceleration of groundings on 777 power by 800 [indiscernible] handful of airlines.

What I struggle to understand is how you get to the 100, £150 million of impact, because the number of aircraft and engine asset is not so high in the end. So can you give us a bit of a feel for how you look at it?

Is it a question of lower number of our flown or is it driven by LLP content, that's your visits that will not happen? Is it all cash?

Anything that can help us to understand how you build the 100-150 would be helpful. And the second question is, I understand that the marketing of the aircraft is made complex by debates on the residual values of the engine in the absence of an independent maintenance network for -- natural for this.

How can you work on improving the remarketing ability of these aircraft going forward? We see what's you're going to do or what's you are doing was more buoyant programs with TotalCare, happy to see [indiscernible] signing on that one.

What can you do for older engine programs? Thank you.

Yeah. I mean, on the first part of the question, I think as I said this morning, actually in the first half of this year we really didn't see an effect and we actually experienced good aftermarket growth year-over-year and the first half of this year.

I'm just trying to recall the percentage of it sort of 5% or 6%, that kind of level. So this is quite a recent thing in terms of what we're seeing.

So you are absolutely right, there have been some specific cases. What we're essentially doing therefore is looking at the whole fleet and taking an assessment across all the airlines which causes us to be more conservative about how that might develop during next year as well.

So it's not just what's already happened, it is what we expect may well happen over the next year . We hope we're being cautious about that.

But that is how we get to the higher number.

Thank you. So, the racial -- it doesn't mean anything I understand.

And on the remarketing ability?

Yeah, I mean you see TotalCare Flex is something that we are just launching and we're obviously having -- none of these situations is one, if we could avoid it happening, we'd much prefer it. So, we will work with the airlines effects to see if there are alternative solutions.

But the primary issue is really around the rank capacity organization. That's what they are trying to address and therefore, sort of us, as trying to make it more liable for them to continue to find, isn't necessarily the right answer for them either.

So, the solution may actually be to try to facilitate those engines moving on to different business, which -- clearly one of the things the TotalCare Flex product enables us to do in terms of working with other customers.

Thanks very much.

Thank you Hugh and thank you all very much for taking part as normally the case, shorter list of questions in the afternoon. Hopefully that's no reflection of interest from shareholders, but please do not hesitate to contact the Investor Relations' team if you have questions and, of course, we'll continue to reach out to you all over the next few days to provide further information on understanding of what we've said today.

Thank you all very much for taking part. Thank you, Warren and thank you David, and good night.